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Unemployment, capital accumulation and labour market
institutions in the Great Recession
Engelbert Stockhammer, Alexander Guschanski and Karsten Köhler
21 May 2014
PKSG Post Keynesian Economics Study Group
Working Paper 1406
This paper may be downloaded free of charge from www.postkeynesian.net
2014 © Engelbert Stockhammer, Alexander Guschanski and Karsten Köhler
Users may download and/or print one copy to facilitate their private study or for non-commercial research and
may forward the link to others for similar purposes. Users may not engage in further distribution of this material
or use it for any profit-making activities or any other form of commercial gain.
Unemployment, capital accumulation and labour market
institutions in the Great Recession
Abstract: The paper restates the post-Keynesian view of unemployment within a NAIRU
framework. In the short run the private effective labour demand need not be downward
sloping because of debt deflation and wage-led demand regimes. In the medium run the
NAIRU will be endogenous because of the social norm character of wage setting and the
supply-side effects of capital accumulation. Capital investment rather than labour market
institutions is the crucial variable that explains changes in unemployment performance. We
provide econometric evidence that the post-Keynesian view holds up well in the recession
following the crisis 2008.
Keywords: unemployment, NAIRU, Post Keynesian economics, panel analysis,
JEL classifications: E12, E24, E25
Acknowledgements. The paper is based on a lecture delivered at the FMM conference 2013
and builds on Stockhammer (2011) and Stockhammer and Klär (2011).
Engelbert Stockhammer
Kingston University
Engelbert Stockhammer, Kingston University, School of Economics, History and Politics,
Penrhyn Road, Kingston upon Thames, KT1 2EE, UK
Email: [email protected]
1
Unemployment, capital accumulation and labour market institutions in the Great
Recession.
I. Introduction
The financial crisis beginning in August 2007 has led to the deepest recession in two
generations. It is remarkable how little has changed within the economics profession in
reaction to this. While there is arguably some rethinking as regards the role and efficiency of
financial markets, there is little questioning of orthodox wisdom as regards macroeconomics
in general and the labour market in particular. The standard New Keynesian (NK) NAIRU
theory regards medium term unemployment as determined by labour market institutions
(LMI). The global financial and economic crisis has illustrated, firstly, that big changes in
unemployment are driven by demand shocks rather than changes in LMI and secondly, that
elevated levels of unemployment persist for a long time. In modern language, the equilibrium
unemployment seems to be path dependent.
In this paper we will reinstate the post-Keynesian (PK) view that in the short, as well as in the
medium term, the labour market is dominated by demand on the goods market, in particular
by capital accumulation. We will set our argument within a NAIRU model to ensure
comparability with modern mainstream economics.
The paper makes three central claims. First, at any point in time there is a well-defined short-
term NAIRU, but it need not be an attractor for actual unemployment. Keynesian theory
distinguishes between the notional, technologically given labour demand curve and effective
labour demand. Effective labour demand need not be downward sloping because of debt-
deflation effects and/or because aggregate demand may be wage led. Second, there is a broad
case for unemployment hysteresis based on social norms in wage bargaining and the supply-
side effects of capital accumulation. The NAIRU will thus be endogenous in the medium term
and demand shocks can have long-lasting effects on unemployment. Third, investment
expenditures are the single most important determinant of unemployment performance
because they are prone to wide fluctuations and determine the capital stock. This assertion is
in sharp contrast to the mainstream NAIRU story, which regards LMI as the main driving
force of unemployment. The contribution of the present paper is to assess the empirical
validity of these claims for the aftermath of the financial crisis. We present an econometric
2
estimation of the NAIRU model accounting for the effects of LMI, capital accumulation and
housing bubbles for a panel of twelve OECD countries for the period 2007-11.
The paper is structured as follows. Section 2 presents a general NAIRU model and highlights
that the mainstream NAIRU story is only one specific interpretation of the NAIRU model.
Section 3 argues that the effective labour demand curve need not be downward sloping (with
respect to the real wage) and that the AD-curve will in general not be downward sloping (with
respect to inflation), except in so far as this is caused by monetary policy. Section 4 maintains
that unemployment hysteresis is ubiquitous due to social norms in wages and the fact that
capital investment has demand as well as supply-side effects. Section 5 surveys the empirical
literature on the determinants of unemployment. Section 6 presents econometric evidence for
the relative explanatory power of capital accumulation and LMI during the Great Recession.
Finally, section 7 concludes.
2. The NAIRU model and the NAIRU story
The NAIRU model is a rather general framework that can accommodate different theories. At
the core it posits a short-run trade-off between unemployment and inflation, i.e. a short-run
Phillips curve. Equilibrium can, in principle be stable or unstable, according to the adjustment
in the goods market. And the NAIRU can be endogenous or exogenous; Stockhammer (2008)
shows that depending on the assumptions about the demand function and about the
endogeneity or exogeneity of the NAIRU, the NAIRU model is consistent with a Monetarist,
NK, PK, or Marxist interpretation.
The general NAIRU model is based on a bargaining view of the labour market. Wage
contracts are not the result of a market clearing process but are negotiated by labour unions
and large firms. The bargaining power of labour positively depends on the level of
employment. The model presupposes that both sides have market power – otherwise there
would be nothing to bargain about. There will only be one level of employment at which the
expected real wage (given inflation expectations) is consistent with the real wage implied by
the prices set by (oligopolistic) firms (given their expectations about input price inflation and
wage inflation). In other words, there will only be one level employment at which the income
claims of labour and capital are consistent. Inflation in the NAIRU model is the result of a
3
distributional conflict and unemployment is determined by effective demand on the goods
market (in the short run). This is the Keynesian feature of the model.
Actual unemployment will only converge to the NAIRU if the goods market adjustment is
standard. If the AD-curve is downward sloping, then the labour market equilibrium is self-
adjusting. When demand pushes unemployment below the NAIRU, there is an increase in
inflation, which in turn decreases demand. Consequently unemployment will increase and
actual unemployment converges to the NAIRU.
Any claim that unemployment is determined by the NAIRU in the medium and long term
requires the additional condition that the NAIRU itself does not change during the adjustment
period.
The NAIRU model has become the dominant framework for the macroeconomic analysis of
unemployment as reflected in textbooks like Blanchard (2006) or Carlin and Soskice (2005).
Following influential work by Layard et al. (1991) the NAIRU theory has become associated
with the argument that actual unemployment is over longer periods primarily determined by
LMI (e.g. IMF, 2003, Nickell et al., 2005). We refer to this as the NAIRU story and argue that
it is a specific (New-Keynesian) interpretation of the NAIRU model.
The NAIRU story, i.e. the assertion that actual unemployment is primarily determined by
changes in labour market institutions, is but one particular interpretation of the NAIRU model
that assumes a standard negative effect of inflation on demand and the exogeneity of
unemployment with respect to its own history. The NAIRU story has become the dominant
view on unemployment and has informed policy recommendations of labour market
deregulation as the key means to change medium term unemployment (OECD, 1994, 2006,
IMF, 2003, European Commission, 2003). We will thus use the terms NAIRU story and
mainstream view synonymously. The model, however, can also be given a PK interpretation.
3. The short run: the NAIRU as a weak attractor
The first key difference between the PK interpretation and the NK view is that the goods
market adjustment will be weak or may not lead towards the labour market equilibrium at all.
4
The NAIRU will thus at best be a weak attractor. In mainstream theory there are two
explanations why the AD-curve is downward sloping. The first is based on the Monetarist
assumption that the money supply is exogenous. An increase in the rate of inflation will
decrease the real money supply and consequently increase interest rates, which will depress
aggregate demand. Some seminal papers on the NAIRU (e.g. Nickell, 1998) use this
assumption.
The second, modern, answer to the question of why the AD-curve is downward sloping is the
central bank’s policy reaction. Most central banks increase interest rates in response to (or in
anticipation of) inflation. This reaction could be part of a strict inflation targeting regime or
part of a more flexible Taylor Rule. Indeed, post-Keynesians have argued that the interest rate
(rather than the money supply) has been the prime monetary policy well before the recent
popularity of the Taylor Rule (Kaldor, 1970, 1982, King, 2002, chapter 8).
The argument that the central bank creates the negative reaction of aggregate demand to an
increase in inflation has important implications for the interpretation of the NAIRU. First, it
highlights that the adjustment of actual unemployment to the NAIRU is essentially due to a
policy reaction, not an economic automatism. Hence, the market system in this view is not
self-adjusting. Second, there are limitations to the effectiveness of monetary policy. Once the
inflation and interest get close to zero, it will be impossible for the central bank to lower real
interest rates (by conventional means). This is the Zero Lower Bound for nominal interest
rates that features prominently in many recent new Keynesian models (de Long and Summers
2012, Eggertson and Krugman 2012).
For the monetary policy rule to equilibrate the economy the private sector reaction to a change
in interest rates has to be sufficiently strong. Keynes had pointed out that there are several
situations, where this may not be the case: in times of financial crisis the demand for money
can become perfectly elastic with respect to the interest rate (a liquidity trap), risk premia may
surge, breaking the usual link between the central bank rate and loan rates, banks may hoard
liquidity and not extend credit (credit rationing) or investors may not react to changes in
interest rates because they are worried about the future (an investment trap).
5
Furthermore the private sector adjustment to a wage-price spiral may be perverse. Fisher
(1933) has argued that (unexpected) deflation increases the real debt burden and may have
negative demand effects. As a consequence different monetary policy rules may result in
different NAIRUs.
A second, closely related question is whether the labour demand curve is downward sloping1:
Keynesians have established that there is a difference between notional labour demand and
effective labour demand (e.g. Lavoie, 2003). If one is willing to assume an aggregate
production function the notional labour demand curve is technologically determined by the
first order condition of a profit maximizing firm. It assumes that there are no demand
constraints for the firm. The effective labour demand is derived from aggregate demand given
changes in (real or nominal) wages and incorporates how AD will change in reaction to
changes in wages.
In a recession firms typically have spare capacity, which implies that the economy is off the
production function and off the (notional) labour demand curve. In a world with excess
capacity a wage cut will have ambiguous effects on aggregate demand. Other things equal,
one would expect a redistribution of income from labour to capital to have a negative effect of
consumption demand (as wage earners are likely to have a higher consumption propensity
than earners of profit income), a positive effect on investment (which depends positively on
retained earnings) and a positive effect on net exports (assuming that the decrease in the wage
share comes with a nominal wage decrease that feeds into domestic prices and improves
competiveness). A priori the total effect of a change in the wage share is thus indeterminate
and can be either positive or negative (Bhaduri and Marglin, 1990). Most of the empirical
studies find that for large economies the demand regime is wage led (Naastepad and Storm,
2006, Hein and Vogel, 2008, Onaran and Galanis, 2012). For example Stockhammer et al.
(2009) find that for the Euro (12) zone a one percentage point increase in the wage share leads
to an increase in consumption by 0.4% (of GDP), a decline of investment by 0.1% and a
decline of net exports by 0.1%, with the net effect being +0.2%, i.e. private excess demand in
1 There have been several microeconomic arguments that the labour demand curve need not be downward
sloping (Card and Krueger, 1994, Manning, 1995), but our concern here is a macroeconomic one.
6
the euro area turns out to be wage led. The effective labour demand may thus be upward
sloping.2
In short, the AD curve is likely to be downward sloping in normal times because of central
bank reaction, but it need not in times of financial turmoil, when monetary policy becomes
ineffective, and once the economy is close to (or in) deflation. The goods market adjustment
to disequilibria on the labour market critically depends on policy reactions and their
effectiveness.
4. The medium term: unemployment hysteresis and endogeneity of the NAIRU
In the medium term the crucial question is whether the NAIRU is affected by actual
unemployment. In the NK literature unemployment persistence is often used to describe
situations where actual unemployment depends on past unemployment, while the NAIRU is
independent of past unemployment. Unemployment hysteresis is used for situations where the
NAIRU itself reacts to changes in actual unemployment. The standard NAIRU literature treats
unemployment persistence as a matter of great practical importance but little theoretical
significance, whereas unemployment hysteresis is regarded as an special case (Nickell 1998).
In contrast, the PK view argues that unemployment hysteresis or NAIRU endogeneity will be
a widespread and pervasive phenomenon.
In the NK analysis of unemployment persistence the long-term unemployed have a different
effect on wages than the short-term unemployed. When people stay unemployed for an
extended period, they start losing their skills or potential employers start discriminating
against them. Also, labour unions may not give full weight to the (long-term) unemployed
when bargaining. There will be a short-term NAIRU that depends on past unemployment and
differs from the long-term NAIRU. Nickell (1998) shows that as long as long-term
unemployment has some effect on wages, the short-term NAIRU will eventually converge to
the (long-term) NAIRU.
2 There is a large literature trying to empirically identify labour demand curves. However national accounting
identities will give rise to spurious negative slopes. Anyadike-Danes and Godley (1989) demonstrated that
estimated labour demand functions will generate negative slopes based on data that were simulated assuming
fixed coefficient technology and mark-up pricing (see also Felipe and McCombie, 2009).
7
In the PK view the case for NAIRU endogeneity is much broader (Skott 2005, Stockhammer
2008). First, if workers’ evaluation of wages follows social norms, e.g. a comparison with
other people’s wages or with their own wage in the past, then any actual wage level can
become accepted as ‘normal’, if it persists long enough.3 When actual unemployment deviates
from the NAIRU the actual wage will also deviate from the equilibrium wage. Our case for
unemployment hysteresis rests on the endogeneity of wage claims rather than on the
disciplining effect (or lack thereof) of the long-term unemployed.
Figures 1 and 2 illustrate the difference between the NK and the PK argument. To simplify
the discussion we will assume a standard goods market adjustment in both cases and that
actual wages are determined by the price setting curve. Figure 1 presents the persistence due
to insufficient wage pressure by the long-term unemployed. There is a NAIRU equilibrium uN
and a demand shock that pushes the economy to T1. Actual unemployment is at level u1 and
actual real wages are at W/P1. Because of high unemployment in period 1, long term
unemployment increases and in the next period the wage bargaining curve will rotate
outwards to WBC2. This curve has the same intercept, but a different slope, which represents
the fact that the long-term unemployed do exercise only limited pressure on wages. As actual
wages are above workers’ wage aspirations at the given level of unemployment, inflation will
be declining and (assuming standard goods market adjustment) output and employment will
increase. As the number of long-term unemployed decreases the slope of the WBC becomes
steeper. The WBC will thus rotate inwards to WBC3 and eventually will approach WBC0,
which is determined only by labour market institutions.
Insert Figure 1
The PK wage norm argument is illustrated in Figure 2. As a result of the demand shock, not
only will actual employment deviate from the NAIRU, but the actual wage will also deviate
from the wage at the NAIRU (W/P)N. We assume that real wages are given by the PSC thus
there is an increase in real wages. If the demand shock lasts long enough for workers to
perceive of the new wage level as normal, the WBC will shift parallel. The extent to which
WBC shifts will depend on how long the economy remains at T1. The longer the economy
stays off equilibrium, the more the wage norms will shift. Eventually the economy will settle
3 Behavioural economics has demonstrated that perceived fairness of wages may impact on labour market
outcomes (e.g. Fehr et al., 1998).
8
at some point, TA, between the original equilibrium and T1, depending on the depth and
duration of the shock and the adjustment speed of wage norms. The NAIRU has changed to
uN,A. There are two key differences to Figure 1. First, there has been a shift of the curve rather
than a rotation, because the change is due to changing wage norms rather than due to the (lack
of) wage pressure due to the long-term unemployed. Second, the WBC is now shifting
towards the actual wage level, rather than rotating towards the original curve. This is because
with each round of adjustment, wage norms will change towards the actual level, whereas in
the number of long-term unemployed is gradually decreasing.
Insert Figure 2
A second reason why the NAIRU will be endogenous is that investment expenditure has
demand-side as well as supply-side effects. The demand-side effects are the familiar
multiplier effects. The supply-side effect is that change in investment expenditures will affect
the capital stock, which has two effects on the NAIRU. First, if one is willing to assume
standard production functions, it will affect the marginal product of labour and thus the price
setting curve. As Rowthorn (1999) has shown, the NAIRU will depend on the capital stock
unless the elasticity of substitution is exactly equal to unity, i.e. unless the production function
is Cobb Douglas. Second the capital stock will also affect the mark up because for a given
level of output, a change in the capital stock will change capacity utilization which will affect
the price setting power of firms (Rowthorn, 1977).
Thus, the NAIRU is endogenous, at least if shocks are strong enough and enduring. Indeed
the empirical literature often concludes that there is unemployment hysteresis.4 Several
surveys find evidence, especially for European countries, for a unit root in the unemployment
rate (Røed, 1996; León-Ledesma, 2002). Stanley (2004) performs a meta-regression analysis
of 24 publications with 99 regressions on the determinants of unemployment and finds a
persistence coefficient close to unity, which indicates full hysteresis. Remarkably, OECD
(2009) is concerned about NAIRU endogeneity: it has revised its NAIRU estimates upward
(and its estimates for potential output downwards) in response to the deep recession 2008/09.
If the NAIRU were exogenous, there would be no reason for the NAIRU to change.
4 Our theoretical concept of hysteresis is defined as (medium-term) endogeneity of the NAIRU. Empirical tests
of the unemployment hysteresis usually test for a unit root in unemployment, which is a stronger condition than
implied by our argument.
9
5. The empirical literature on LMI, capital accumulation and unemployment
While the Keynesian view regards capital accumulation as the key variable determining
aggregate demand, the mainstream view argues that unemployment is, beyond short-term
fluctuations, effectively determined by LMI. However, the strong policy conclusions of
orthodox economists who call for labour market deregulation are not unanimously backed by
their empirical findings. IMF (2003) estimates a panel of 20 OECD countries and finds
significant effects for employment protection, union density, the tax wedge, the interest rate
and productivity shocks. Nickell et al. (2005) estimate a non-linear least square panel with
country-specific time trends and find significant effects of the unemployment benefit
replacement ratio and (the change in) union density, some interactions, labour demand shocks
and import price shocks. Both find a very high degree of unemployment persistence. More
recently, Flaig and Rottman (2013) estimate a panel of 19 OECD countries from 1960 to 2000
and find statistically significant effects of employment protection, benefit replacement rate
and the tax wedge. The centralisation of the wage bargaining process significantly reduces
unemployment. They also report that coefficients vary substantially across countries.
However, many other studies find mixed, weak, or no effects of LMI. Blanchard and Wolfers
(2000) present a panel investigation for 20 OECD countries and highlight the interaction of
macroeconomic shocks and institutions. They conclude “While labor market institutions can
potentially explain cross country differences today, they do not appear able to explain the
general evolution of unemployment over time” (Blanchard and Wolfers 2000: 2). Baker et al.
(2005) attempt to replicate previous findings by means of a panel with 5-year averages; they
conclude that there is “no meaningful relationship between [the] OECD measure of labor
market deregulation and shifts in the NAIRU” (Baker et al 2005: 107). Bassanini and Duval
(2006) use a dynamic panel analysis of 21 OECD countries over the 1982-2003 period and
find that benefit generosity and the tax wedge are the only classic LMI to have a significant
effect. Baccaro and Rei (2007) offer an extensive attempt to replicate previous estimations
employing various econometric estimation techniques and find significant effects only of
union density among the labour market institutions. Two recent studies follow Blanchard and
Wolfers (2000) accounting for LMI and macro shocks. EC (2012) investigates the impact of
LMI and macro shocks on the NAIRU using a panel analysis of 13 EU countries over the
10
1985-2009 period. It confirms the strong impact of LMI, but also notes the importance of
demand factors such as the interest rate and volatility of employment in the construction
sector due to housing bubbles. However, these factors are not clearly articulated in the
theoretical framework. Avdagic and Salardi (2013) present a panel regression of 32 OECD
countries from 1980 to 2009 and of 10 CEE countries (1990-2009). They find a significant
effect only for wage bargaining coordination which reduces unemployment. Union density
and benefit generosity are significant in some specifications, but do not survive the robustness
tests. Notably, none of these studies include capital accumulation as a potential determinant of
the NAIRU, i.e. none of these studies allows for a Keynesian null hypothesis.
In their policy reports the OECD and the ECB discuss labour market performance in the
aftermath of the Great Recession in a more pragmatic approach, without adhering strictly to
the NK NAIRU model. At an early stage of the crisis OECD (2010, 2011) discusses risks and
policy implications resulting from persisting unemployment and the danger of a jobless
recovery. Although empirical data do not indicate extensive withdrawal from the labour force
until now, the report worries that this might happen in the future. A variety of labour market
reforms such as activation policies, reduction of benefit replacement ratios and restricting
early retirement is suggested in order to reduce unemployment persistence by increasing the
labour force and labour market flexibility. This corresponds to the NK concept of persistence,
although the authors do not explicitly refer to any theoretical framework. While the report
does emphasise the role of aggregate demand management, the policy suggestions are focused
on stimulating demand through removing market-barriers – especially regarding the fiscal
imbalances in most OECD countries. ECB (2012) reports that employment in countries with a
strong pre-crisis credit boom and current account deficits was hit especially hard by the
recession. Employment losses were above-average in the manufacturing and construction
sector. Unemployment persistence due to skill-mismatch is recognised. However, in its policy
conclusions the ECB highlights only wage flexibility as the cure for unemployment. While
the OECD does see some role for demand management, there is no mention of it by the ECB.
Neither of them assigns any significance to capital accumulation.
The Keynesian view holds that capital accumulation is the main determinant of
unemployment performance in the medium term. Econometric evidence supporting strong
effects of capital accumulation has been found by a range of different methodologies but
11
studies notably differ in the extent to which they control for LMI, i.e. to what extent they
encompass the mainstream explanation. Stockhammer (2004) uses time series analysis for
five countries and controls for the tax wedge, unemployment benefits and union density.
Arestis et al (2007) apply a vector error correction model for nine countries and control for
unemployment benefits and strike activity. Both studies find strong effects of capital
accumulation. Karanassou and Snower (1998) and Karanassou et al. (2008) estimate a system
of labour demand, wage setting and labour supply curves and (controlling for a limited set of
LMI) find strong effects of capital accumulation (for the UK and Scandinavian countries
respectively). Rowthorn (1995) and Alexiou and Pitelis (2003) report significant effects of
capital accumulation with a cross-section and panel approach respectively, but do not control
for any LMI.
The most encompassing work with panel data is Stockhammer and Klär (2011) who perform
a panel analysis for OECD countries controlling for the full set of LMI used in OECD (2006).
They find strong capital accumulation effects, substantial effects of interest rates, but very
small effect of LMI. Simulations show that the explained contributions of changes in actual
capital expenditures clearly dominate the contributions of other factors.
6. Unemployment during the 2008 crisis
Our econometric analysis follows Stockhammer and Klär (2011), who propose a PK version
of the NAIRU which encompasses standard NAIRU factors. However, we focus on the crisis
period and estimate a panel for the period 2007-20115. Thereby, just as in other corresponding
literature, homogeneity of coefficients has to be imposed across countries (Blanchard and
Wolfers 2000, Baccaro and Rei 2007). The baseline regression equation takes the following
form:
where u, INFL, LMI, MS and ACCU denote unemployment, inflation, labour market
institutions, macroeconomic shocks and, capital accumulation respectively. This equation is a
general reduced form of the NAIRU. The change in the inflation rate (∆INFL) is a measure of
5 Unlike Stockhammer and Klär (2011) we do not use five year averages to account for business cycle
fluctuations because of the brevity of the chosen period.
12
the deviation of actual unemployment from the NAIRU. This is a feature of all NAIRU
models. The standard NK NAIRU model highlights the role of LMI (e.g. Nickell 1998),
whereas extended versions of the NK model include also various macro shocks (e.g.
Blanchard/Wolfers 2000). The PK version includes capital accumulation and posits that this
will be the key variable, but allows for the effects of standard variables as well. ACCU
embodies the demand-side effect of investment, as well as the supply-side effect of the capital
stock.
We include five labour market institutions, namely employment protection legislation (EPL),
active labour market policies (ALMP), minimum wages6 (MW), union density (UD) and
gross benefit replacement ratio (GRR). All these are wage push variables and are expected to
have a positive sign, apart from ALMP which are supposed to decrease search unemployment
and mismatch. The data are taken from the OECD database. The GRR annual time series is
intrapolated from two-year data.7 As macroeconomic shocks we consider the long-term
interest rate (LTI) and, following EC (2012), a variable measuring housing bubbles
(HOUSEBUB). Data on unemployment rates, real net capital stock, real gross fixed capital
formation8, the consumer price index, employment in the construction sector, total
employment and long-term real interest rates are taken from the AMECO database provided
by the European Commission. ACCU is the ratio of gross fixed capital formation to the
capital stock. ∆INFL is the second derivative of the logarithm of the consumer price index9.
We follow EC (2012) and construct HOUSEBUB, as the deviation of the ratio of employment
in the construction sector to total employment from its mean. Data availability is constrained
by the availability by LMI data and HOUSEBUB. Depending on the specification we cover 8
to 12 OECD countries.
The most commonly used estimation technique in our context is a fixed-effects (FE) panel
estimator in levels (EC 2012, Flaig and Rottmann 2013, Avdagic and Salardi 2013). However,
6 Values of MW have been divided by 100.
7 We have chained two separate time series of gross replacement rates. The first series ranging from 1961 to
2005 is based on Average Production Worker wages, whereas the second time series (2005 to 2011) is based on
Average Worker wages. Further details can be found at OECD Benefits and Wages: Statistics (available at
http://www.oecd.org/els/benefitsandwagesstatistics.htm). 8 Gross fixed capital formation captures the demand side of aggregate investment. Unfortunately, the AMECO
dataset does not allow distinguishing between residential and non-residental investment. Future research could
include these two types of investment separately. 9 Values of INFL, ACCU and HOUSEBUB have been multiplied with 100.
13
using this method results are plagued with autocorrelation problems. Thus, like Baccaro and
Rei (2007), we prefer the first difference estimator.10
Table 1 presents the results for several specifications. Specifications 1, 2, 3, 4 and 6 use first
difference estimators; specification 5 employs a FE estimator. Standard errors are corrected
for autocorrelation and cross-section heteroscedasticity. Specifications 1-5 are based on the
sample 2007-11; specification 6 extends the sample to 1986-2011 to confirm that our model is
consistent with data before the crisis period.
Insert Table 1
Specifications (1) and (2) are versions of the standard NK NAIRU interpretation. The
coefficient estimate on ∆INFL is statistically insignificant in specifications 1 and 2.. The LMI
variables perform poorly in the basic NAIRU specifications. ALMP is statistically significant
in specification 1 and 2 and has a perverse sign; MW is weakly significant only in
specification 1. All other LMI variables are statistically insignificant. In the short sample
long-term interest rates remain insignificant in all specifications. In specification (2)
HOUSEBUB is statistically significant at the 1% level. Short, our findings give little support
to the standard NAIRU theory.
The PK specification (3) fares better, with ACCU being statistically significant at the 1%
level. A one percent increase in capital accumulation would reduce unemployment by 2
percentage points. HOUSEBUB remains statistically significant at the 1% and ∆INFL at the
5% level. Among the LMI only GRR is significant at the 10% level. The following
specifications check the robustness of this model.
Specification 4 excludes minimum wages, which increases the sample of countries from 8 to
12. GRR becomes insignificant, but the other coefficients don’t change substantially.
Specification 5 uses the FE estimator instead of the difference estimator. ACCU and
HOUSEBUB remain statistically significant at the 1% and ∆INFL at the 5% level. Among the
LMI variables, MW is now statistically significant at the 5% level and has a negative effect on
unemployment. GRR has a statistically significant positive effect at the 1% level.
10
Estimating an autoregressive distributed lag model gave clear support for the difference specification.
14
Specification 6 extends the sample to the period 1986-2011, which confirms our results
regarding the negative impact of ACCU and HOUSEBUB on unemployment. We obtain three
significant LMI variables – UD, MW and ALMP. While the latter remains with a perverse
sign, the positive effect of UD on unemployment is in line with previous findings
(Stockhammer and Klär 2011). The MW is significant on the 10 % level. However, the main
drivers are clearly HOUSEBUB and ACCU.
7. Conclusion
The paper has highlighted the differences between the PK and the mainstream (NK) analysis
of unemployment. We have used a NAIRU framework and argued that its bargaining
conception of the labour market and the fact that goods market adjustments are crucial make it
consistent with PK theory. The PK approach differs from the NK one in that it highlights that
the short run adjustment relies on monetary policy, which is unlikely to be effective in times
of financial crises. In the medium term hysteresis phenomena are pervasive features of the
labour market because of the social norm aspect of wages and the supply-side effects of
capital accumulation. In our view labour market performance is driven by demand shocks,
most importantly by investment behaviour. We have substantiated this view empirically with
an econometric panel analysis of the recent crisis experience, which demonstrates that capital
accumulation (as well as housing bubbles) rather than LMI are the main drivers of
unemployment performance. The PK view lends itself to a very different policy conclusion
than the orthodox view. Wage flexibility may be counterproductive in a crisis and active fiscal
policies are needed to stabilise employment.
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Figure 1. Standard unemployment persistence
T1
uN
WBC3
u1
WBC0
T0
T2
W/P
PSC
u
WBC2
W/P1
W/PN
18
Figure 2. NAIRU endogeneity due to social wage norms
T1
uN
WBC3
u1
WBC0
T0
T2
TA
uN, A
W/P
PSC
u
WBC2
W/P1
W/PN
19
Table 1
Specification 1 2 3 4 5 6
Sample 2007-2011 2007-2011 2007-2011 2007-2011 2007-2011 1986-2011
Est. Method FD FD FD FD FE FD
Variable coeff t-value coeff t-value coeff t-value coeff t-value coeff t-value coeff t-value
C 21.090 1.929*
∆INFL 0.050 0.979 -0.090 -1.571 -0.108 -2.599** -0.040 -1.434 -0.117 -2.769** -0.040 -1.505
EPL 0.055 0.041 1.314 0.905 1.295 1.113 0.852 0.938 2.685 0.959 -0.261 -0.419
ALMP 3.484 7.690*** 1.746 2.659** -0.504 -0.715 0.316 0.652 -0.382 -0.584 0.946 3.300***
MW 0.076 1.749* 0.057 1.152 -0.054 -1.612 -0.093 -2.388** 0.020 1.665*
UD 0.220 0.669 -0.099 -0.231 -0.038 -0.112 0.174 1.529 0.319 1.017 0.103 2.061**
GRR -0.039 -0.257 0.062 0.384 0.166 1.792* 0.023 0.408 0.254 2.970*** -0.032 -1.188
LTI 0.052 1.023 -0.002 -0.017 0.053 0.525 -0.019 -0.280 -0.012 -0.076 0.017 0.508
HOUSEBUB -0.945 -4.249*** -0.889 -4.834*** -0.799 -4.426*** -1.055 -7.100*** -0.709 -7.060***
ACCU -2.003 -4.373*** -1.372 -6.028*** -1.914 -4.547*** -0.988 -6.521***
Observations 45 32 32 54 34 193
Cross-sections 11 8 8 12 9 12
periods 5 5 5 5 5 26
Mean dep var 0.709 0.469 0.469 0.295 7.108 -0.032
S.D. Dep var 1.609 1.568 1.568 1.389 3.742 1.014
S.E. of regression 0.883 0.709 0.558 0.541 0.391 0.556
Adj. R2 0.699 0.796 0.874 0.848 0.989 0.700
DW 1.866 2.689 2.436 2.532 3.194 1.450
NOTE: Countries included in specification 1: Austria, Belgium, Canada, France, Ireland, Netherlands, Portugal, Spain, United Kingdom, Japan, USA
specification 2 and 3: Austria, Belgium, Canada, France, Netherlands, Spain, Japan, USA
specification 4: Austria, Belgium, Canada, Denmark France, Finland, Germany, Italy, Japan, Netherlands, Spain, United States
specification 5: Austria, Belgium, Canada, France, Luxembourg, Netherlands, Spain, Japan, USA
specification 6: Belgium, Canada, France, Greece, Ireland, Japan, Luxembourg, Netherlands, Portugal, Spain, United Kingdom, United States
Definitions: DF = first difference estimator
FE = fixed effects estimator
20
DW = Durbin-Watson Statistic
***,** and * denote statistical significance at the 1%, 5% and 10% level, respectively.